Up-to-the-minute advice, information, resources, and, on occasion, commentary on federal and New Jersey state income taxes, and the various New Jersey property tax rebate programs, and insights and observations on tax policy and professional tax practice, by 40-year veteran tax professional Robert D Flach.

Saturday, January 27, 2007

BUSH'S PROPOSED TAX TREATMENT OF HEALTH BENEFITS

It seems that just about every tax blog has made some comments on George W’s health insurance proposals. I guess I should add my 2 cents.

First, let’s look at how health insurance premiums are treated for tax purposes under current law.

(1) The days of employer-provided health insurance coverage are pretty much gone. Most workers in the private sector pay for part, or all, of their health insurance coverage, either directly or via payroll deduction. Any portion paid by the employer is tax-free. In many cases, when an employee pays for his health insurance premiums via payroll deduction the amount withheld is treated as “pre-tax” under a “Section 125” (aka “cafeteria”) employee benefit plan. The employee payment is deducted from taxable wages, thus reducing his Adjusted Gross Income (AGI), as well as from Social Security and Medicare wages and in many cases state wages (although not NJ state taxable wages), on the W-2.

(2) A self-employed individual, and a 2% sub-S corporation shareholder, can claim an “above-the-line” deduction for 100% of the health insurance paid, up to the amount of net earnings from self-employment reduced by ½ of the self-employment tax paid. This deduction reduces his AGI, but not self-employment tax.

(3) An employee who pays his own health insurance, either directly to the insurance company or via payroll withholding that is not pre-tax, first must be able to itemize on Schedule A to claim a deduction for the amount paid. If he can itemize, health insurance premiums are included in total medical expenses, which are subject to a 7½% of AGI exclusion.

The employee with employer-provided or pre-tax health insurance, (1) above, comes out the best of all under current tax law. Any premiums he pays reduces his federal, and possibly state, income tax, his Medicare, and possibly Social Security, tax, and, as it reduces his AGI, could increase the tax benefits of items affected by AGI.

The self-employed individual, (2) above, comes out second best. The premiums paid reduce his federal, and possibly state, income tax and could produce side benefits from a reduced AGI. They do not, however, reduce self-employment tax. However, a Schedule C filer can get a “back-door” reduction of self-employment tax if he employs his spouse and pays family health insurance premiums as an “employee benefit”.

The taxpayer who pays for health insurance directly, or is not a participant in a Section 125 plan, (3) above, is basically screwed. Depending on the amount of the premiums and his income he may be able to deduct some of the premiums from federal, and possibly state, income tax. But they do not reduce his Medicare or Social Security tax or his AGI.

Many lower income taxpayers who pay for health insurance directly, and there are a lot who have absolutely no insurance coverage at all, get no tax benefit because they already pay no federal or state income tax.

George W has proposed taxing employer-provided health insurance, doing away with pre-tax treatment of employee-paid premiums, and providing a new standard deduction for health insurance.

The taxpayer in category (1) loses slightly because the premiums paid no longer reduce his Medicare and possibly Social Security tax.

The taxpayer in category (2) is basically unaffected.

The taxpayer in category (3) comes out the most ahead, assuming his income is such that he gets a tax benefit from the new standard deduction.

Taxpayers in all three categories could end up with a few more bucks in their pockets if the standard deduction amounts of $7,500 and $15,000 are more than the actual amount of premiums paid, or provided by an employer.

The low-income taxpayer who already pays no federal income tax continues to be screwed. So does the lower-income taxpayer with no insurance coverage who pays tax at the 10% or 15% bracket. If he does not have insurance because he cannot afford it, a tax benefit of from $750 (Single at 10%) to $2,250 (family at 15%) will barely make a dent in the cost of health insurance. This is especially true in New Jersey where the cost of high-deductible, and I do mean high, health insurance premiums ranges from $4,000+ for single coverage to $12,000+ for family coverage.

In addition, the George W proposal would do away with employer-sponsored “flexible spending accounts” (FSA) for medical expenses and the itemized deduction for medical expenses, after the 7½% exclusion, for everyone except Medicare beneficiaries. This is not good.

So I would say, “Thanks, but no thanks” to Dubya. There has got to be a better way. While his proposal will help some taxpayers who pay for their own coverage, those in category (3), it does nothing whatsoever to address the real problem – the growing number of Americans who cannot afford health insurance.

1 comment:

Anonymous
said...

Did you forget about the Earned Income Tax Credit that those low income families receive which in a way rebates the social security taxes they have paid. If they are already paying no Federal, no state or no city income tax, then getting EITC credits and of course $1000 Federal child tax credits plus now in NY as of 2007, they will get NY child tax credits (not sure of the amount since I don't have children under 17), then I don't think they are are "being treated unfairly." They are already getting so many breaks, the middle class is paying for them anyway.

They don't pay when they use the Hopsital E.R.s because they don't have enough income and the hospitals won't pursue them while the middle class who has no insurance most assuredly will get the bill and be told to "pay it off over time."

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